Fitch Downgrades Nestle to 'AA-'; Outlook Stable


Friday, June 30, 2017 2:19 PM / Fitch Rating

Fitch Ratings has downgraded Nestle SA's (Nestle) Long-Term Issuer Default Ratings (IDR) and senior unsecured ratings to 'AA-' from 'AA', and affirmed the company's Short-Term IDR at 'F1+'. The Outlook on the Long-Term IDR is Stable. A full list of rating actions is available at the end of this commentary.

The downgrade follows Nestle's announcement of a CHF20 billion share buy-back programme commencing from 4 July 2017. This will increase funds from operations (FFO) adjusted net leverage to around 2.2x by 2020 and reduce free cash flow (FCF) margin to an average of 2.7%, weakening the group's financial flexibility. Fitch expects the operating environment to remain challenged by innovation, changing consumer habits and slowing organic growth.

Positively, the ratings of Nestle continue to reflect the stability and strength of its business as the world's largest food company, benefiting from scale and geographic diversification. The group is well-placed to continue defending its operational scale and market share, despite more subdued growth potential and changes in supply chain dynamics, and to improve margins, thus supporting our Stable Outlook.

Key Rating Drivers

Weakened Financial Profile: We expect Nestle to fund the announced share buyback programme predominantly from debt, which will increase FFO adjusted net leverage to 2.2x by 2020, above our negative guidance of 2.0x. Such leverage is not commensurate with a 'AA' rating, supporting a downgrade of the rating by one notch to 'AA-'. In our rating case projections, we also factor in the sale of Nestle's US confectionary business in 2018.

Scope to Grow Profit Margins:  Fitch conservatively expects profit margins to increase only moderately by 2020. In line with its peer Unilever NV/PLC (A+/Negative), we expect Nestle to be able to identify cost efficiencies and to achieve some margin uplift. However, this will likely take time to deliver and involve execution risk. However, we estimate that FFO margin will decline to 14% through to 2020 from an average of 15% during 2012-2016 due to higher cash interest and tax costs. This, together with by capex (including intangibles) remaining above 5% of sales, will constrain FCF margin (after dividends) to an average 2.7% over 2017- 2020, below our prior negative sensitivity of 3%

Organic Revenue Growth Softening: We expect overall group revenue growth to be lower in the range of 3%-4% over 2017-2020 due to a structural shift towards healthier foods, changing consumer habits and increasing competition. Nestle has revised down its organic growth target for 2017 to 2%-4% and to mid-single digits by 2020, from its historical long-term target of 5%-6%.

Solid Business Profile: Nestle's organic growth performance remains at the top end of major fast-moving consumer goods peer group and the group continues to achieve market share gains in several categories and countries. This helps keep Nestle's business risk profile in line with the 'AA' rating category for the sector.

Diversification Complements Resilient Business: Nestle benefits from high business stability and low capex and R&D spending requirements, despite operating in highly competitive segments, compared with other highly rated corporations. Furthermore, within its industry Nestle benefits from a portfolio of several high profit margin categories, from ownership of some of the strongest brands as well as from consistent and successful innovation. Balanced geographical diversity between developed and emerging markets further supports the 'AA-' rating.

Foreign Exchange Volatility: Although Nestle enjoys balanced geographical diversity between developed and emerging markets, profits are exposed to emerging market currency devaluation. A portion of operating costs is denominated in domestic currencies but translation risks can still erode reported profits.

Moreover, while Nestle maintains local currency-denominated debt at many of its emerging markets subsidiaries, the majority of the group's debt is in hard currencies, thus limiting the benefits of these natural hedges. Mitigating this risk is Nestle's track record of gradually increasing prices, albeit with a time lag, in countries suffering from currency devaluation.

Derivation Summary

Nestle is well-positioned as the largest food company in the world by revenue and profit and enjoys balanced geographical diversity between developed and emerging markets. The announced CHF20 billion share buyback programme weakens Nestle's financial profile, which is now more commensurate with a 'AA-' rating relative to other sector peers. No country-ceiling, parent/subsidiary or operating environment aspects impact the ratings.

Key Assumptions

Fitch's key assumptions within our rating case for the issuer include

- Group revenue growth of 3%-4% per annum to 2020

- Operating margin of 15.8% by 2020

- Annual pre-dividend FCF margin averaging 8.8% to 2020

- Capex (including intangibles) averaging 5.2% of revenues to 2019

- Moderate growth of dividend share

- CHF20 billion share buyback between 2017 and 2020

- Bolt-on acquisitions totalling CHF500 million in 2017 and CHF1.5 billion-CHF1.6 billion in 2018 and 2019

Rating Sensitivities

Future Developments That May, Individually or Collectively, Lead to Positive Rating Action

We do not anticipate an upgrade in the immediate term but future developments that may, individually or collectively, lead to positive rating action include

- FFO adjusted net leverage consistently below 2.0x (2016: 1.4x) as a result of asset sale proceeds, or improvement in operations.

- Renewed commitment to operating with credit metrics consistent with a higher rating

- Future Developments That May, Individually or Collectively, Lead to Negative Rating Action

- FFO adjusted net leverage sustainably above 2.3x

- Deterioration in FCF generation after dividends, taking FCF margin below 2.5% (2016: 3.9%)

- Significant or prolonged downturn in emerging markets, or in main developed markets, causing a slowdown in organic growth (below 3%) and reduction in profits (EBIT margin below 14%)

- FFO fixed charge coverage (including rents) below 9x (2016: 12.9x) 

As of end-2016 Nestle had liquidity of CHF18.4 billion, comprising CHF7.2 billion of Fitch calculated cash and cash equivalents which are readily available for debt service and committed undrawn back-up bank facilities of CHF11.2 billion. This is sufficient to cover 100% of Nestle's short-term debt obligations (CHF12.1 billion) consisting of bonds and bank loans due in the coming 12 months as well as outstanding commercial papers (CHF7.2 billion).  

Full List of Rating Actions 
Nestle SA

--Long-Term IDR downgraded to 'AA-' from 'AA'; Outlook Stable--Short-Term IDR affirmed at 'F1+';

--Senior unsecured debt downgraded to 'AA-' from 'AA'

Nestle Holdings, Inc (USA)

--Senior unsecured debt downgraded to 'AA-' from 'AA'

Nestle Finance International Ltd

--Guaranteed commercial paper affirmed at 'F1+'

--Guaranteed bonds downgraded to 'AA-' from 'AA'

Nestle Holdings (UK) PLC

--Guaranteed commercial paper affirmed at 'F1+'

Nestle Capital Corporation (USA)

--Guaranteed commercial paper affirmed at 'F1+'

Nestle Australia Ltd

--Guaranteed commercial paper affirmed at 'F1+' 

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